One of the great innovations made possible with the advent of blockchain technology is the development of triple-entry accounting.
Triple-entry accounting is a term for a new method of accounting, that was proposed in the 1980’s. It was more recently popularized when Ian Grigg associated it with blockchain technology. Triple entry accounting is an enhancement to the traditional double entry system in which all accounting entries involving outside parties are cryptographically sealed and linked through a smart contract to a third entity. But to understand the value of this we need to appreciate a little bit the history of accounting systems and where we are coming from.
There is evidence that even during the Mesopotamian era, some four or five thousand years ago, a fairly complex accounting of property, purchases, and expenditures existed on tablets.
Extensive accounting methods also existed in Greece since the fifth century B.C.
By the middle ages a fairly advanced system of accounting had developed, but before the advent of double-entry accounting, accountants relied on a chart of balance sheet accounts to record financial transactions. This single-entry accounting system is a method of bookkeeping relying on a one-sided accounting entry to maintain financial information. This creates a system that is very difficult to examine for accountability.
Consider the extreme problems such a system would pose today. Companies would publish balance sheets without Income Statements. There would be no way for investors to scrutinize the changes in equity.
With a single-entry system, all you have to do is remove a line in the ledger and that money no longer exists. There was no way to verify, no way to audit, no way to reconcile, for people to agree. Likewise, it would be nearly impossible to build a single entry system, that by itself supports the reporting needs of public corporations, companies that sell shares of stock to the public.
The development of double-entry accounting opened the realm of accounting into a whole new world.
Double entry bookkeeping revolutionized the field of financial accounting during the Renaissance period some six hundred years ago. By the 1400’s, a Franciscan friar finally codified the double-entry system and it swiftly became the standard with the merchants of the Italian states. Whereas simple ledgers had long been the standard for record keeping for merchants, the church and state treasuries, the growth of long-distance trade and creation of the first joint stock companies resulted in firms whose records were too voluminous and complicated to provide any assurance of accuracy to their users.
Modern financial accounting is based on a double entry system. Described simply, double entry bookkeeping allows firms to maintain records that reflect what the firm owns and owes and also what the firm has earned and spent over any given period of time. The idea is you want to minimize the errors in your bookkeeping so what you do is that for each transaction you do two entries in your books.
The issue with double entry accounting is that there is not really any connection between the different sets of books each firm holds. The records are themselves separate, so if Bob wants to cheat a little bit he can say that maybe this transaction was only eight tokens and he doesn’t have to pay as much in taxes.
Likewise, as the organizational structure and sophistication of companies developed they were expected to share their records with outside stakeholders, such as investors, lenders and the state. This created the problem of how outsiders could trust the company’s books and thus required auditors.
Although you did your double entry accounting in your book there was absolutely no guarantee that the bank, or whomever else you were dealing with, saw the transaction the same way and recorded the same numbers. In fact, as part of an audit, one would have to write to the bank and ask did this organization really have this money at this date and do you agree on this number.
So all this massive amount of administration could be removed if we have an economy-wide accounting system.
Triple-entry accounting can be thought of as a way of agreeing on objective economic reality.
Triple entry accounting is an enhancement to the traditional double-entry system in which all accounting entries involving outside parties are cryptographically sealed by a third entry. Thus placed side by side, the bookkeeping entries of both parties to a given transaction are congruent.
The third entry in the system, entered into the blockchain, is both a receipt and a transaction. It’s proof that something happened between two parties, which goes beyond the receipts that each party holds in double entry system.
Since the entries are distributed and cryptographically sealed, falsifying them or destroying them to conceal activity is practically impossible.
A seller books a debit to account for cash received, while a buyer books a credit for cash spent in the same transaction, but in separate sets of accounting records. This is where the blockchain comes in: instead of these entries being recorded separately in independent sets of ledgers, they occur in the form of a transaction between wallet addresses in the same distributed, public ledger, creating an interlocking system of permanent and objective accounting records.
The idea about triple-entry accounting is that instead of each firm having their own books the transaction goes through a contract and this contract includes everything about the transaction. This may record what the product was, the prices, who is the seller and who is the buyer. It’s digitally signed and it can have a hash that links to further public documentation.
So the books are now linked together by this third entry, the triple-entry, that can potentially be viewed for external auditing purposes.
Triple-entry is quite a confusing term because we are not creating a third entry, we are just linking two separate double entries. That link is created via a smart contract that works to ensure that the two double entries in separate legal entities are always the same; this is auto enforced by the smart contract and as with all smart contracts it is tamper proof.
TRIPLE-ENTRY ACCOUNTING ADVANTAGES
The advantages of a triple entry system are numerous in terms of reconciliation, transparency, trust, and auditing. Triple-entry accounting allows us to reconcile the balance, the transaction, and the reporting process, so that organizations can trust their own books.
Typically, each party is responsible for maintaining their own financial records. However, this can lead to fraud or other errors. The use of triple-entry accounting reduces this risk by keeping a non-biased record.
Many blockchains are publicly visible or easily exposed to external viewing, making them transparent.
With blockchain networks, the entry is the transaction, because the assets are on the blockchain. The ledger is not an account of what happened, it is what happened.
And as the ledger is tamper proof this makes it trustworthy.
For auditing, blockchain accounting is ideal as it creates a list of transactions, thus it creates an immutable history of all the exchanges within the system which could be mined using data analytics. There is a perfect audit trail.
“We came up with double-entry bookkeeping as a species over 500 years ago and it led to the accumulation of capital on a very large scale with the Industrial Revolution and with a lot of the institutions that we have today. When we’re able to further refine that with triple entry bookkeeping it really opens up whole new vistas and possibilities for corporate governance, the transfer of money, accounting. We have this globally distributed decentralized ledger that everybody has the exact same copy of and all the debits and credits that move the bitcoins or the Satoshis around in this ledger, everybody agrees on consensus that those transactions actually happen and boom you got that verification so you have the debit the credit and the confirmation by the Bitcoin network” – Trace Mayer